So, you have been laid off or left your previous employer. This transitional period may be full of decisions, such as balancing unemployment insurance, health care insurance, and other important life decisions. Of course, retirement planning is still important, but what are your options with your old 401(k)?
Stay in the existing plan
Most companies will allow you to keep your retirement savings in their plans after you leave. Your money will continue growing tax deferred. However, if you have less than $5,000 in your account, your money may be automatically cashed out and sent to you.
As you progress through your career it is likely that you will have multiple employers. According to a Bureau of Labor Statistics 2019 study, the average worker who was born between 1957 and 1963 held an average of 12.3 jobs during their career. If you choose to leave your 401(k) at each employer that you leave, by the end of your career you may have several accounts that you need to keep track of. Multiple 401(k)s may also lead to certain plans not being aligned with your risk tolerance as you move closer to retirement.
Move the money to a new employer’s plan
If you start a new job with an employer who offers a 401(k) plan, you will be able to roll over your assets to the new plan. This will give your assets the ability to continue growing tax deferred while consolidating into one plan. Most 401(k)s have a wide range of investment options, but you will still be limited to the investment funds offered within the new plan.
Roll over the money to an IRA
You can roll over the funds to an IRA with a bank or brokerage firm. This IRA can be used every time you need to roll over a 401(k) without having to open a new account each time. The money will continue growing tax deferred and will be available for you in retirement. Some 401(k)s allow for a post-tax Roth contribution. If your former contributions were going into the Roth, you can roll the money into a Roth IRA.
IRAs offer you more investment choices than 401(k)s as you can invest in anything from stocks, bonds, mutual funds and more. There are many online platforms that enable investors to buy and sell investments on their own. But if this sounds like it is outside your comfort level, you can find a financial adviser who will help you manage your investments while planning for retirement.
Cashing out your 401(k) is an option, but it should be considered only if there is an immediate need for the money. This option will set you back when planning for retirement. The withdrawal will be taxable at both the federal and state level and you may incur an early withdrawal penalty of 10% if you are not yet 59.5.
Withdrawing from a traditional 401(k) will always be taxable, but there are a few ways to avoid the early withdrawal penalty. The IRS allows you to withdraw your money if you stopped working for your former employer in or after the year you reached age 55. However, this exception does not apply to assets rolled over to an IRA. Additionally, if you have been laid off due to COVID-19 the CARES Act now allows withdrawals up to $100,000 penalty free. The CARES act also allows the taxes from this withdrawal to be spread out over a three-year period.
If finances are tight and you need the money today you can withdraw money if you deposit the funds back into an IRA within 60 days. This strategy is known as an indirect rollover and will avoid the taxes and penalties. This can be a short-term solution if your intention is to keep your money dedicated to retirement, but you need a short-term cash infusion today.
Whether your departure from your previous company was planned or an untimely surprise, your decision on how you handle your 401(k) can be a choice within your control. In many ways this interruption or job transition may be the start of a new chapter in life. This new chapter does not have to interrupt your retirement planning and financial well-being. Being informed on your options will help you thoughtfully move into the future with your retirement savings.
Matt Stratman is a financial adviser at Western International Securities in Southern California. His focus is helping business owners and entrepreneurs who are planning for retirement. With a strong, client-centered approach he creates personalized investment strategies to help them reach their financial goals. Matt is extremely passionate about retirement planning, believing the better prepared a person is, the more fulfilling their retirement will be.
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